GSEs Remain Far from Sound in Regulator's Eyes

It could be "several years" before the scandal-wracked government-chartered housing enterprises are out of the woods, their safety and soundness regulator told Congress.

Even Freddie Mac, which had been thought to have turned the corner on its accounting problems, is still in the doghouse with the Office of Federal Housing Enterprise Oversight, said acting director James Lockhart, who has been on the job just over a month.

"Both companies are several years away from having adequate internal controls" in place, he told the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises.

Mr. Lockhart said the sanctions in place at Fannie Mae - including a freeze on its mortgage portfolio - can be lifted at the sole discretion of the director. (The sanctions are part of a $400 million settlement Fannie signed with OFHEO and the Securities and Exchange Commission last month.)

The regulator added that it's "hard to see their total removal for several years." And he cautioned lawmakers that a similar limit on Freddie Mac is not out of the question, either. The company is "at least two years away from have acceptable accounting and risk management" in place, he told the panel.

The hearing was called by subcommittee chairman Richard Baker, R-La., to review OFHEO's recent report on the accounting irregularities at Fannie Mae.

Rep. Baker was perhaps the first lawmaker - a "lone wolf," House Financial Services Committee chairman Michael Oxley, R-Ohio, called him - to sense something was amiss with the GSEs. And he lit into both companies again last week.

"Despite all the years this committee has been digging into these issues," Rep. Baker said, "OFHEO's examination of Fannie Mae revealed breaches of propriety and judgment so deplorable in nature and pervasive in reach that's it's almost as if we were barely scratching the surface."

He added that "we have a long road" to travel before things are right with the GSEs. "We have a very long way to go."

In his testimony, Mr. Lockhart, who was making his first appearance on Capitol Hill since being nominated by President Bush, rehashed OFHEO's report, which detailed "an arrogant and unethical corporate culture" at the very top of the company and a board of directors that was, at best, asleep at the wheel.

"The examination found an environment where the ends justified the means," he said.

He stopped short of using the word "fraud," saying that is best left to lawyers at the SEC. But he said the Fannie Mae leadership was able to "stonewall" his undermanned, underfunded agency at practically every turn because it "was an extremely strong corporation with very strong lobbying activities."

He faulted not just senior executives but also directors, who contributed to Fannie's problems "by failing to be sufficiently informed and act independently," even after accounting issues became apparent at rival Freddie Mac.

Many board members under the old regime of ousted former chairman/CEO Franklin Raines remain in place. At last week's hearing Rep. Baker said Mr. Raines appears to have perjured himself when he testified in 2004 before the panel about the GSE's accounting problems. (See sidebar.)

In particular, Mr. Lockhart singled out the board's audit committee for not providing adequate oversight, and the compensation committee for approving a pay structure "based on a single measure - earnings per share that was easily manipulated by management."

According to OFHEO's damning report, Fannie Mae proved that appraisers aren't the only ones who can "hit the number" time after time after time. In Fannie's case, the company was able to reach its earnings per share targets "with uncanny precision each quarter," Mr. Lockhart testified.

For their part, the handful of subcommittee members in attendance used the hearing to chide their Senate colleagues for failing to act on a bill that would create a new, independent regulator for Fannie and Freddie and it give greater powers to oversee the giant financial institutions.

The House has passed legislation, but the Senate's far different version has yet to be scheduled for floor debate.

"There is no justification" for the Senate's refusal to act while the House-passed bill "gathers dust," said Rep. Barney Frank, D-Mass., the full committee's ranking minority member.

Noting that both companies still continue to perform their vital housing mission, Rep. Frank said "there is life after manipulation." Indeed, that Fannie and Freddie are still performing their mission of funneling funds to local lenders is a testament to their "validity and strength," he said.

To emphasize the point, the always colorful Massachusetts Democrat said the difference between Enron and Fannie Mae is that Enron has collapsed while Fannie Mae is still standing. So "do not punish the institution," he added. "The value is not the institution but the housing."

Rep. Oxley wondered why OFHEO's report was far more critical than the one produced earlier this year by a team headed by former Sen. Warren Rudman. Mr. Lockhart replied that what happened at Fannie Mae is "not just an accounting scandal" but a case where officers were involved in "a total conflict of interest."
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